Australia's Future Tax System

Retirement Income Consultation Paper

2. A broad and adequate retirement income system

A broad and adequate retirement income system protects those who are unable to save against poverty in their old age, and provides the means for individuals to save for their retirement.

Australia's retirement income system accommodates the needs of individuals with different circumstances. This includes those with a full working life and those who are unable to work. The Age Pension acts as a safety net to support those with a short work history, while the SG and voluntary savings enable individuals with a long work history to fund a higher retirement income.

However, not all individuals have the same expectations about their standard of living in retirement. While some may regard a particular level of retirement income as adequate, others may regard it as too much or too little. Individuals therefore have a responsibility for achieving their desired retirement income level where it differs from that provided by the Age Pension and compulsory saving.

Summary of key messages from submissions

Submissions back the Age Pension as a means of providing basic support to those unable to save for their retirement. Many submissions comment on the significant effect introducing the SG will have on the standard of living of future retirees and call for it to include more individuals.

One submission calls on the Panel to set a clear aspirational goal for retirement incomes.

A range of submissions argue that the Age Pension should allow full rate Age pensioners to live with dignity and have a small level of discretionary income.

Many submissions comment on the retirement incomes of individuals who are not covered by the SG. Most of these submissions call for the self‑employed to be brought into the SG system. A number express concern that the current exclusion of the self‑employed from the SG system means that employers may prefer individuals to be independent contractors instead of employees.

Other submissions call for the removal of the $450 per month exemption that determines if the SG is paid to employees and for the inclusion of individuals on workers compensation, the long‑term unemployed and carers. Others recommend allowing individuals who are not working to be eligible for the government superannuation co‑contribution, or for the government to pay superannuation contributions into an account on their behalf.

One submission argues that increasing compulsory superannuation contributions or concessions is unlikely to significantly increase retirement incomes for individuals with broken work patterns. The submission argues that this raises the need for an adequate Age Pension as part of the retirement income system.

Some submissions raise taxing foreign source pensions in the same way as superannuation. Others suggest that expatriates should be allowed to transfer retirement savings accumulated in another country into Australia's superannuation system without limit.

Adequacy of the retirement income safety net

The Pension Review

The Age Pension is intended to provide a basic acceptable standard of living, taking into account community standards. It is paid to Australian citizens and permanent residents irrespective of previous workforce participation or earnings. The balance between the role of the Age Pension as a safety net and its role as a supplement to retirement savings is a threshold issue for the design of the Age Pension and its integration with the retirement income system.

The issue of the adequacy of the Age Pension in its role as a safety net is a key focus of the Pension Review. It is also examining relative needs, for example the relative expenditure needs of single pensioners compared to couple pensioners, other support mechanisms and the system's sustainability. The Pension Review is examining a range of benchmarks and indicators, such as:

  • budget standards, which involve developing detailed household budgets specifying the items that a household needs to achieve a particular standard of living;
  • relative income poverty measures;
  • international comparisons;
  • changes in real pension rates over time (that is after adjusting for inflation); and
  • wellbeing indicators, which look beyond income to explore how retirees perceive their retirement (for example, whether they believe that their overall standard of living is similar to, worse than, or better than before they retired).

Another key question about the adequacy of the Age Pension in its role as a safety net is that of indexation and the benchmark against which the Age Pension is set. That is, it is necessary to consider how to maintain adequacy over time as well as at a particular point in time. Currently, the Age Pension is indexed in line with the Consumer Price Index, or set at a benchmark of 25 per cent of male total average weekly earnings, whichever is greater.

Income support is only one element of policy assisting those in need. Other support is provided through services and concessions that are more closely related to the specific needs and circumstances of older Australians, such as assisting with the needs associated with illness, disability or caring responsibilities.

This review into the retirement income system will not reconsider the issues evaluated by the Pension Review.

The outcomes of the retirement income system

The outcomes of the retirement income system are commonly discussed in terms of whether they are adequate or not. There is no consensus as to how to measure adequacy for an individual, and any decision needs to take account of what benchmark is used to judge adequacy. Individuals will also have different ideas on what is adequate depending on their pre‑retirement income and other circumstances such as whether they have children or own a home. It is also challenging to measure the value a retiree places on their leisure (Box 2.1).

Common adequacy benchmarks used to assess the retirement income system are replacement rates, budget standards and wellbeing measures. A description of these measures is outlined in Appendix D. The most commonly used measure is the replacement rate, which this section uses to discuss the outcomes of the retirement income system.

Replacement rates arising from the Age Pension and SG

Treasury uses replacement rates to project the outcomes of the retirement income system. Some replacement rates compare the first year of retirement expenditure with expenditure in the last year of an individual's working life. Bingham and Rothman (2004) consider this approach to be misleading as it does not include the effect of real increases in the Age Pension and overstates the effect of the assets test in the first year of retirement.

Treasury projections use an after‑tax income, based on average expenditure over an individual's retirement. Table 2.1 sets out Treasury projections of the replacement rate for an individual who retires after a full working life (35 years) of having received 9 per cent SG.

Table 2.1: Replacement rates based on income(a) — using CPI discount(b)

Income as a proportion of AWOTE(c) Replacement rate
0.75 79
1.0 68
1.5 56
2.5 48
  1. Appendices D and E provide further discussion of replacement rates and how they are calculated.
  2. Consumer price index.
  3. AWOTE is average weekly ordinary time earnings and is approximately $1,150 a week.

Source: Australian Treasury projections.

Replacement rates fall as income increases, while overall retirement expenditure grows as income increases. The average expenditure for an individual on 75 per cent of AWOTE is projected to be $46,153 (in 2008 dollars) and $68,761 for an individual earning 2.5 times AWOTE.

Table 2.1 uses consumer price inflation to determine how much purchasing power an individual retains in retirement. Treasury considers that adjusting for consumer price inflation best indicates whether an individual's real standard of living has increased over time. Some groups argue that using inflation to determine purchasing power overvalues the increase in living standards, and wages is a better indicator. Table 2.2 shows the replacement rates for the SG and the Age Pension using wages instead of inflation to determine changes in purchasing power. The use of wages reduces the replacement rates shown in Table 2.1, as the Age Pension is kept constant in today's dollars, while its value increases over time if inflation is used.

Table 2.2: Replacement rates based on income(a) — using wages discount(b)

Income as a proportion of AWOTE(c) Replacement rate%
0.75 65
1.0 56
1.5 47
2.5 40
  1. Appendices D and E provide further discussion of replacement rates and how they are calculated.
  2. Increases deflated by wages.
  3. AWOTE is average weekly ordinary time earnings and is approximately $1,150 a week.

Source: Australian Treasury projections.

Box 2.1: Retirement and leisure

During their working life, individuals will divide their time between paid work and other activities that they may prefer doing, such as hobbies, work around the home or volunteer work. In many cases, the desire to attain a particular level of income drives the choice to work. Among other factors, individuals' wellbeing will be determined by their spending power and time spent outside paid work.

When individuals retire, they have more leisure time to devote to other activities. This is of value to retirees and influences their perceptions of their wellbeing in retirement. Findings from the Household Income and Labour Dynamics in Australia Survey, Wave 3, 2004, reveal that around 73 per cent of retirees believe their standard of living is similar or better than before they retired even though most retirees have less spending power than when they worked. This may reflect greater flexibility in the use of their time.

Replacement rates compare a person's spending power in retirement to what they had while they worked. This is different to a comparison of their wellbeing, which would include the value of increased leisure time in retirement, among other factors.

Aggregate replacement rates

Replacement rate measures are generally calculated using a retirement income comprising the Age Pension and superannuation accumulated under the SG. The third pillar of the retirement income system, voluntary savings, is not included as individuals use this pillar in different ways.

A significant proportion of individuals have superannuation contributions greater than the 9 per cent SG. An estimated 1.25 million individuals make salary sacrifice contributions (ABS 2008). Salary sacrifice contributions are more likely to be made by older individuals (around 22 per cent of those aged 55‑64 years, compared to 3 per cent of those aged 15‑24 years) and individuals with higher wages (around 29 per cent have gross weekly incomes of $2,000 or more, compared to 2 per cent with gross weekly incomes of less than $300). The Australian Treasury, using contribution data from 2004‑05, estimates that 2.5 million individuals have superannuation contributions above 9 per cent. Individuals also make voluntary after‑tax superannuation contributions and have assets outside of superannuation.

Including these additional savings significantly increases replacement rates. Table 2.3 shows aggregate replacement rates for individuals with superannuation and other savings. The rates are calculated on an average basis for these individuals. They also take into consideration the various retirement ages and workforce participation of individuals within this group. They do not include the benefits an individual receives from owning their own home (not having to pay rent) or if they generate an income from their home through the use of a reverse mortgage.

Table 2.3: Aggregate replacement rates(a)

Income range Replacement rate if retiring in 2040‑41

Low income earner — 2nd Decile


Middle income earner — 5th Decile


High income earner — 8th Decile


  1. Appendices D and E provide further discussion of replacement rates and how they are calculated.

Source: Australian Treasury projections.

Government support versus self‑provision

Debate on the adequacy of the retirement income system is ongoing. As a concept, adequacy can range from ensuring a minimum retirement income sufficient for an individual to afford the basics of participating in society, to providing an income which meets an individual's retirement income expectations. The concept of adequacy for the retirement income system will significantly affect the extent to which the outcome is supported by the government (through the Age Pension, tax concessions and other incentives) and the individual (through saving).

The Senate Select Committee on Superannuation (2002) suggested replacement rate targets as an appropriate objective. However, replacement rate targets can result in unintended consequences and need to be carefully considered. Too high a target can result in individuals forgoing more consumption during their working life and saving more than they consider necessary to fund their retirement. This may also result in excess saving being transferred to younger generations. It may also encourage early retirement, which could create problems in an economy with an ageing population. Too low a target may result in insufficient retirement income for individuals on low incomes during their working life.

The trade‑offs associated with reaching a target need to be considered. For example, if achieving a replacement rate for all income earners is considered appropriate, how is this to be achieved? It could include relaxing eligibility rules so more individuals receive some part of the Age Pension or supporting savings with greater concessions. Alternatively, an increase in compulsory saving could make it easier for higher income earners to attain the replacement rate. The first option would reduce the progressivity of the system and increase the tax burden. The second option may adversely affect the living standards of low and middle income earners during their working years by requiring them to save more than they prefer.

Other decisions would be required if the system was intended to provide a particular income level (benchmark income). For example, at what level would the government's contribution be set and how much government support would be needed once an individual achieved the benchmark income? Depending on the benchmark income this may be more progressive than a system aimed at providing a replacement income.

Retirement incomes for non‑employees and immigrants

While the SG provides comprehensive coverage of employees, for some groups it will have less of a role in providing a retirement income. These include individuals with broken work patterns (intermittent workers, carers and individuals with disabilities), those with income less than $450 per month and the self‑employed. The retirement income system may have different results for immigrants, and expatriates returning to Australia, depending on their age when they arrive in, or return to, Australia and any assets or savings which they can transfer to Australia.

Individuals with broken work patterns

An individual's retirement income depends on their savings, largely from their earned income. Therefore, periods outside the workforce not only decrease an individual's standard of living before retirement but also in retirement. Women are more likely to have career interruptions because of caring responsibilities, and are therefore not able to benefit from superannuation policies in these periods.

For many individuals with broken work patterns, or no work history, changes to superannuation policy may have minimal effect on their retirement income.

Policies which support an efficient, robust economy and remove disincentives to work may have a greater effect on these individuals' retirement income than superannuation policies. For example, policies which support child care may encourage more women to return to the workforce. This may have a greater influence on their retirement income than increasing superannuation concessions.

The Age Pension is likely to provide the majority of retirement income for individuals with broken work patterns. Therefore, consideration of the adequacy of the Age Pension is likely to have the most immediate impact on their retirement income. The Pension Review is considering this issue.

Immigrants and returning expatriate Australians

Immigrants have different experiences with the retirement income system depending on their age, skills and savings. Immigrants who arrive in Australia aged in their twenties are more likely to have a similar experience as an Australian‑born resident. An immigrant in their forties will have less time to accumulate SG if they retire at 65 years.

Around 80 per cent of permanent immigrants are aged less than 35 years. Over two‑thirds arrive in Australia as skilled migrants. This suggests most immigrants should have a reasonable period in the workforce. As with individuals with broken work patterns, the Age Pension is likely to provide the majority of the retirement income for those immigrants who may not have a full working life in Australia.

Expatriate Australians also have different circumstances. Like some immigrants, many expatriates will have built up savings and assets overseas which they can live on in retirement in Australia. Others may not have many assets but may qualify for support from another country's retirement income system. Some submissions raise the taxation of this foreign sourced income in Australia and recommend treating this income like superannuation. Other submissions note that some expatriates are unable to transfer equivalent superannuation savings in overseas funds into Australian superannuation funds if they are greater than the cap on after‑tax contributions. This cap is $150,000 a year, however, individuals under age 65 years can bring forward up to two years of future contributions.

The self–employed

Submissions have called for the self‑employed to be included in the compulsory superannuation system. Unlike employees, the self‑employed have different characteristics and generally fall into two main categories:

  • those with minimal business assets; and
  • those who have business assets which they can sell to potentially finance their retirement.

The proportion of the working population that is self‑employed has been gradually decreasing over the past two decades. At the start of the 1990s, approximately 15 per cent of the work force was self‑employed. Today the proportion is around 12 per cent.

Although they are not required to make superannuation contributions, many self‑employed individuals do so voluntarily. Approximately two‑thirds of owner‑managers in unincorporated enterprises (a proxy for the self‑employed) make superannuation contributions (ABS 2008). The self‑employed may be eligible for tax deductions and the government co‑contribution for the superannuation contributions they make.

Many self‑employed also save outside superannuation, including through their business. Taking into account wealth held outside of superannuation for individuals in the 55‑64 years age group, the self‑employed have a higher proportion of individuals with assets above $150,000 than full‑time employees. Many self‑employed may qualify for the small business capital gains tax concessions intended to encourage investment in their business and use the proceeds from the sale of these assets for retirement purposes.

The exclusion of the self‑employed from the SG can affect the choice of whether an individual works as an employee or is self‑employed. For example, an individual who can attain total remuneration of $50,000 as an employee or in self‑employment would retain more of their earnings in that year if they were self‑employed and did not make a superannuation contribution. Some submissions also suggest that some employers prefer independent contractors to employees. However, there are circumstances where a business will have to make contributions under the SG system for an individual who is an independent contractor.

The self‑employed may prefer to have access to liquid savings rather than superannuation, given the higher risks associated with being self‑employed. Requiring compulsory superannuation saving may also influence the business decisions of the self‑employed especially in the establishment phase of their business.

Consultation questions

Q2.1 As the SG system matures, it will become a greater part of an employee's retirement income. What are the implications for individuals partially or fully excluded from the mature SG system (the self‑employed, individuals with broken work patterns such as carers, women and migrants), and how can the retirement income system best accommodate these groups?

Q2.2 Noting that the adequacy of the Age Pension is being considered by the Pension Review, what is an appropriate concept of adequacy for the retirement income system? Should it be to ensure there is a minimum level of income in retirement, to replace a proportion of income earned prior to retirement, or some other alternative?

Q2.3 What should the role of the government be in assisting individuals to meet their retirement income expectations in relation to the support provided by the Age Pension, the level of compulsory savings and incentives to make additional savings? Should the role of government change as an individual's income increases over their working life?